A prior post had helpfully pointed out that the IRS is not accepting contract for deed/land contract as a “sale” for purposes of $8,000 homebuyer tax credit. Specifically, see http://www.irs.gov/newsroom/article/0,,id=206291,00.html, question number 9, which reads as follows:
"Q. Does a taxpayer qualify for the first-time homebuyer credit upon the signing of a contract for deed, since normally the deeds are signed and executed but held in escrow until the provisions of the contract have been met?
A. Generally, no. A taxpayer is not eligible for the first-time homebuyer credit unless there is a completed sale. Under the facts presented, the contract for deed may not be a completed sale because all of the provisions of the contract have not been met. However, the determination of whether there is a completed sale would depend on the facts and circumstance of the particular case and perhaps state law. (New 06/12/09)"
My response: The IRS is on crack, this is why we have tax lawyers. Sometimes the IRS takes a position on the law that is contrary to the law itself. This is one of those cases.
To determine whether or not a sale (of a personal residence, for example) has occurred for tax purposes, the courts have stated that they will look to see who has the “benefits & burdens” of ownership, and have explicitly stated that title to the property is only one factor in the equation. On several occasions, the courts have determined ownership to reside in someone other than the title holder.
One such case, and a very widely quoted one, is Grodt & McKay Realty, Inc. vs. Commissioner, 77 TC 1221 (1981). In Grodt, the Tax Court set forth several tests to see who owns a piece of property for tax purposes. Lets apply the tests to a land contract:
(1) Whether legal title passes - OK, they’ve got us on that one;
(2) how the parties treat the transaction - generally as a sale, one for the good guys.
(3) whether an equity was acquired in the property - always the case under state law, we are now 2-1.
(4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments, no brainer, 3-1
(5) whether the right of possession is vested in the purchaser, make that 4-1
(6) which party pays the property taxes, normally the resident & not the investor, draft correctly and we are at 5-1
(7) which party bears the risk of loss or damage to the property, normally not the investor, usually appears with insurance clauses requiring buyer to pay for insurance. 6-1 if properly drafted
(8) which party receives the profits from the operation and sale of the property, again, the buyer & not the investor, 7-1.
This is a no brainer, whoever answered the IRS question was thinking of “open transaction” doctrine, which applies to lease options & not land contract/contract for deed. It’s not the first time that the IRS has found itself on the wrong side of the law, it won’t be the last. Often, the IRS at least has a decent argument on a “grey” issue. Here, I think they do not even have that. This is a no brainer with a well-drafted land contract/contract for deed. Maybe the person who penned the answer felt it, notice how much they hedged their answer.
There’s plenty of other law on this issue that I did not take the time to cite. That law is consistent with Grodt and does not help the IRS. They are dead wrong on this one and are simply using their power to discourage a practice they do not like. Talk about a Praetorian Bureaucracy.